Timing Options for a Startup with Early Termination and Competition Risks

TL;DR

This paper models the timing options of startups considering early termination and competition risks, providing explicit valuation formulas and analyzing how these risks influence entry and exit decisions.

Contribution

It introduces an analytical framework for valuing startup timing options under exogenous risks, including explicit formulas and strategic insights.

Findings

Early termination risk prompts earlier entry and exit decisions.

Competition threat influences the timing strategies non-trivially.

Explicit valuation formulas for startup options are derived.

Abstract

This paper analyzes the timing options embedded in a startup firm, and the associated market entry and exit timing decisions under the exogenous risks of early termination and competitor's entry. Our valuation approach leads to the analytical study of a non-standard perpetual American installment option nested with an optimal sequential stopping problem. Explicit formulas are derived for the firm's value functions. Analytically and numerically, we show that early termination risk leads to earlier voluntary entry or exit, and the threat of competition has a non-trivial effect on the firm's entry and abandonment strategies.